What is SAFE Note Drafting?
A SAFE (Simple Agreement for Future Equity) note is a popular tool for financing a startup. How it works is that an investor invests capital in exchange for the startup promising equity during a future priced funding round.
There are important things to consider with SAFE notes, such as their pros and cons, what key terms are included in a SAFE note agreement, and how a lawyer can help you with SAFE note drafting to ensure clarity and validity.
What are SAFE Note Pros and Cons?
SAFE notes provide various advantages and disadvantages.
Pros
- No pricing required. Founders aren’t required to value or price the company during pre-seed or seed financing stages.
- No debt obligations. Since SAFE notes aren’t loans, they don’t include interest rates or maturity dates that force founders to repay the money.
- Quick process. SAFE notes only require basic documentation, which speeds up the financing process.
- Founder protection. SAFE notes protect founders from loss of control because equity isn’t granted to investors until a specified event.
Cons
- Risk of uncapped dilution. In later rounds, a startup company’s valuation can increase significantly, which can result in early investors claiming a larger percentage. This can dilute the founders’ shares.
- No investor rights. Investors lack ownership or voting rights until the conversion.
- Non-conversion risks. Should it happen that the company does not have a priced funding round, the note doesn’t convert, which can mean the investor receives little or no return.
What are Key Terms to Include in a SAFE Note?
A SAFE note usually contains the following core components.
Valuation Cap
A valuation cap establishes the maximum valuation at which investors’ investments convert into equity. It has to be clearly defined so that the investor is safeguarded against excessive dilution in later rounds of financing.
Discount Rate
A discount rate lets the investor’s SAFE investment convert into equity at a lower price than the price paid by new investors in future rounds. This can serve to reward early investors for having taken on early-stage risks.
Trigger Event
This is the event that triggers SAFE note conversion into equity. It usually occurs in a future funding round, such as if a certain amount of funding has been raised by the company.
Investor Rights
SAFE notes can be negotiated by investors so that they have rights, such as:
- Pro-rata rights. These ensure investors can take part in future funding rounds to safeguard the percentage they own.
- Liquidation rights on insolvency. If the company is liquidated, these rights may require it to repay the investor’s SAFE investment before assets are given to shareholders.
MFN Clause
A MFN, or Most Favored Nation, clause means that if the company issues new SAFEs to other investors with more favorable terms, original investors will be able to make use of them.
Investment Details
This specifies the exact amount of money invested and provides legal names of the company and investor. The date of execution should also be included to reduce uncertainty.
What are Pitfalls When Drafting a SAFE Note?
There are some common pitfalls that can occur when writing SAFE notes. Here are some to avoid.
- Insufficient investor protection. A SAFE note should clarify all investor rights, such as anti-dilution provisions, so that they’re not susceptible to value fluctuations.
- Failure to consider financial consequences. During the conversion, there could be unexpected tax or accounting consequences. It’s important to consult with a financial professional to avoid any surprises.
- Non-compliance. Startups must comply with all securities regulations when issuing SAFE notes to prevent legal penalties or risk invalidating the financial arrangement.
How Does a Lawyer Help with SAFE Note Drafting?
A SAFE note should be clear and provide clarity on important terms, such as valuation caps and conversion triggers. This reduces the risk of confusion or disputes. It also helps all parties to understand their duties.
Here are some practical ways in which a lawyer will help you draft a SAFE note.
- They’ll draft the SAFE note so it reflects your fundraising goals and company structure.
- They’ll explain all key terms that must be included, such as discount rates.
- They’ll avoid using ambiguous language that can result in future disputes.
- They’ll comply with all securities laws and regulations. This prevents both parties from being exposed to legal risks.
- They’ll negotiate with the other party so that all terms included in the SAFE note agreement are favorable.
- They’ll check that the SAFE note is aligned with other financing documents so that there’s consistency.
- They’ll provide legal guidance throughout the financing process to prevent you from making costly mistakes.
Where to Find a Lawyer for SAFE Note Drafting
If you need to hire a lawyer to draft your SAFE note, you might not know where to find one. Finding a lawyer doesn’t have to be a stressful process, as you can easily locate a qualified lawyer on an online legal platform such as ContractsCounsel.
ContractsCounsel is one of the biggest online legal marketplaces that gives you access to a curated network of vetted lawyers. All lawyers have the expertise required for drafting and reviewing contracts.
To request that a qualified lawyer on the ContractsCounsel platform drafts your SAFE note agreement, follow these simple steps.
1. Go to the ContractsCounsel marketplace and post your project for free.
2. Wait to receive lawyer bids. You’ll receive multiple bids from lawyers directly on the platform.
3. Review the lawyers' profiles to choose the most suitable one. The platform provides extensive lawyer data, such as their location, client ratings, years of experience, field of expertise, and previous projects completed on the platform.
4. Connect with a lawyer who matches your legal requirements. Hire them to draft your SAFE note so that it’s compliant with all regulations and transparent to prevent disputes.
If you already have a SAFE note you’ve drafted, don’t hesitate to get it reviewed by a lawyer on the platform. This will give you peace of mind that it’s comprehensive and valid.
